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The purchase of a call option gives the holder the right to a long futures position (buy a futures position) at the strike price. In this case, the writer (or seller) of the call option is obligated to provide the holder with a long futures position. Purchasing a put option protects the holder against falling cash prices. If prices fall, you have the right to a short futures position at the higher strike price. Basically, you have the right to place a hedge at the strike price.

A short futures position at a high price means you can offset with a buy at the current lower market price and receive the gain. Purchasing a call option (the right to buy a futures position) protects the holder of the call against rising prices.

If prices rise, you have the right to a long futures position at the lower strike price. A long futures position at a low price means you can offset with a sell at the current higher market price and receive the gain.

An option’s premium (market value) is influenced by two factors. The first factor, intrinsic value, is determined by the strike price relative to the current market price of the underlying futures contract. As an example, assume you purchase a December live cattle put (the right to a short position on December live cattle) with a strike price of 75.00 cents.

If the current market price of the December live cattle futures contract is below 75.00 cents (let’s say 73.00 cents), you have the right to a short December live cattle futures position at the strike price of 75.00 cents. Since you can offset the short futures position with a buy at the current market price of 73.00 cents, this put option can be turned into a 2-cent per pound gain. Basically, this particular put option gives you (as the holder) the right to sell at a price 2 cents above the current market price.

Thus, the obvious value (or intrinsic value) of the put is 2 cents per pound. Anytime a put’s strike price is above the current market price of the underlying futures contract, the put option has intrinsic value. The right to sell a futures contract at a price higher than the current market price has obvious value.

A call option (the right to a long futures position) has intrinsic value when the strike price is below the current market price of the underlying futures contract. If you buy a December live cattle call with a strike price of 75.00 cents, the call has intrinsic value when the December live cattle futures price is above 75.00 cents.

For example, a 75- cent live cattle call has an intrinsic value of 2.00 cents per pound if the underlying futures contract is trading at 77.00 cents. Basically, you (as the holder of the call) have the right to buy at a price 2.00 cents below the current market price. The right to buy a futures contract at a price below the current market price has obvious value.

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